Bond notes have dominated much of the social and economic discourse ever since the governor of the Reserve Bank of Zimbabwe John Mangudya made public his intention to introduce a surrogate currency via the avenue of an export incentive.
By Durban Marukutira
A lot of economists and financial experts have sought to dissect the matter, but there appears to be a gap in terms of explaining what really has caused the monetary authorities to go the bond notes route. This article will make an attempt to explore that journey using proper evidence and economic principles.
It is important from the outset to highlight that the government faces an untenable fiscal situation where over 94% of its revenues are channeled towards recurrent expenditure. This to a greater extent has left the government with no fiscal headroom to fund capital and other expenditures. It is even worrying to note that, faced with dwindling tax revenues owing to the biting economic conditions, the government has principally resorted to the issuance of Treasury Bills to fund expenditure. In his Mid-term Fiscal Policy Review Statement, Finance minister Patrick Chinamasa made the following admission:
“Financing of the budget deficit has been primarily through issuance of Treasury Bills by the Reserve Bank on behalf of Government. However, lack of capacity to service domestic debt has also seen roll-overs, which are posing some financial risks on domestic debt instrument holders and domestic financial institutions. This situation, unfortunately, is not tenable and is undermining the stability of the financial sector and overall economy.”
From the above statement, it is disturbing to note that the government has been failing to honour Treasury Bill maturities and resorting to rollovers. In the same Mid-term Fiscal Policy Review statement, Chinamasa makes another very heart-rending revelation when he indicates that the Government of Zimbabwe account at the Reserve Bank has been in overdraft over the period January to June 2016. The pinnacle of the overdraft was June 30 2016 where the account was down an astonishing $726 million as shown by figure 1 (top, right):
Chinamasa goes on to forecast that, if not mitigated, the position has the potential to worsen to almost US$1.1billion by end of December 2016 if measures to arrest government expenditure — which have since been nullified through a press statement dated 13 September 2016 by Information minister Chris Mushohwe — are not implemented.
It is within the context laid above that Zimbabweans ought to view the contentious issue of bond notes. From the above it is clear bond notes, though hidden behind the shadow of an export incentive, are clearly a natural reaction of a government that is faced with a dwindling funding base and has resorted to the only avenue of funding left: printing money.
If we are to further analyse the impact of the US$726 million overdraft, it is worth mentioning that the figure relates quite closely with the exponential growth in the total Real-Time Gross Settlement (RTGS) market position, which for some time has remained north of US$1 billion, from a previous average of almost US$500 million. It is apparent from the inter-relation between the government account balance and the RTGS market position that what Chinamasa preferred to call “rollovers” is, in fact, some creative accounting tendencies wherein the RBZ is debiting the Government of Zimbabwe’s unfunded account to finance Treasury Bill maturities due to institutional investors.
Excessive government borrowing has also had a very devastating effect in that whenever the government becomes the single biggest player in domestic debt markets, it crowds out other private players who ordinarily should have had access to debt for their working capital requirements and efficiently allocating those resources in key economic activities that feed into the growth matrix. This partly explains the deflationary environment that most companies have endured over the duration of the multicurrency system, hence the decline in Gross Domestic Product growth statistics.
Enter the US$200 million question
It is important at this juncture to highlight that the US$200 million figure for bond notes was neither plucked out of thin air nor is it the outcome of some thumb suck exercise.
A proper analysis of commercial banks’ trends for holdings of cash notes and coins from the beginning of 2015 to August 2016 using publicly available monthly RBZ reports is quite revealing. Whilst it is clear from the trend line (See figure 2) that commercial banks’ holdings of bank notes and coins have been declining at an increasing rate over the period, it is vital to note that the average commercial bank notes and coins over the period is around US$200 million.
So in arriving at the US$200 million quantum of bond notes, the idea was to try and match commercial banks’ stock of foreign currency to the amount of bond notes. While it might sound noble at face value, the dictates of Gresham’s Law are such that bad money always chases away good money. If that obtains, then the bond notes will almost certainly become the dominant currency insofar as its use as a medium of exchange is concerned, while the US dollar will be relegated to being a store of value and a safe haven asset. This scenario provides fertile ground for the emergence of a parallel market wherein the bond notes will almost certainly be trading at a discount to the official exchange rate of 1:1 on the formal market.
It is common cause that the best way to kill your neighbour’s dog is by first alleging that it has rabies. The same logic was applied when bond coins were literally forced on the transacting public on the back of the claim that small change was a challenge to retailers and the transacting public alike.
With bond notes the excuse was the need to boost exports in the economy. But like a certain friend of mine observed in a long discussion, exports by their very nature are an autonomous function. In other words, they are influenced by exogenous factors which fall outside the influence of the countries from which the goods or services originate.
His argument made sense to me because I do not see how Zimbabwe can be able to influence the price of its gold, tobacco or let alone the amount of remittances that its foreign nationals remit back home.
A more suitable strategy would have been to levy an import tariff which would then be passed on to exporting clients who produce the same products we seek to replace from our import basket. That would at least have yielded positive results in saving the little foreign currency and lowering the cost of production for exporting customers.
How the government chewed bank nostro accounts
Several theories have been propagated as to how the Reserve Bank of Zimbabwe played a chief role in the current cash and nostro crisis. The explanation is found in the RBZ’s Exchange Control Operational Guideline and Directive 3 of 2015(ECOGAD3/2015). The directive says:
“Authorised Dealers shall be required to maintain a Nostro Account balance threshold of 5% of Total FCA balances (Total Bank Deposits) on a daily basis. In addition, Authorised Dealers shall also maintain limits of foreign currency cash holdings equivalent to 15% of Total FCA Balances on a daily basis”
What the above entails is that all commercial banks would not hold more than 5% of total deposits in a nostro account. Furthermore,banks were not allowed to hold more than 15% of their total deposits in the form of cash.
Anything in excess of the 5% and 15% thresholds for nostro and cash would have to be forfeited to the RBZ in exchange for RTGS balances. In instances where a bank was non-compliant, a penalty fee of 2,5% would be levied to the defaulting institution.
Using nostro funding and cash from the proceeds of the above directive, the RBZ and the government would effectively spend money primarily obtained from the issuance of Treasury Bills to bankroll government’s payments for power, foreign travel, vehicles, and tractors among other imports. In all this, the country was bleeding foreign currency out of the market, hence the presently obtaining situation where banks have no cash notes or enough nostro balances to cover importing customers’ imports.
The ECOGAD3/2015 directive was no different to the Gideon Gono era in which banks were forced to surrender foreign exchange held on behalf of embassies, non-governmental organisations and other forex-generating customers in return for domestic currency.
The consequences going forward
Panic cash withdrawals
Given a tainted history of monetary losses as a result of currency exchanges, the introduction of bond notes is likely to trigger a large-scale deposit run on banks as people seek to hold USD cash notes before the bond notes are introduced. If this is to happen, then for the foreseeable short-term period the cash crisis is most likely to worsen.
Low USD cash deposit traction
Against a backdrop of limitations on withdrawals, it is likely most customers will desist from depositing cash via official banking channels since they will not be able to withdraw USD cash notes on demand.
Emergence of parallel market
When the bond notes are launched, a parallel market will emerge wherein the bond notes will be traded at a discount to the official market rate of 1:1 with the US dollar. This scenario is already evident, with reports that cash notes are selling at a premium of between 5%-10% on the parallel market. It is most likely the minimum discount factor for the bond note on the parallel will be in same range of 5%-10% before factoring other variables that feed into the parallel market price.
Shortage of fuel, basic commodities
On the back of a shortage of cash notes and nostro funding, it is inevitable that retail operators will encounter challenges funding their orders. This may result in acute shortages of goods on the local market. As a result, rent-seeking tendencies such as hoarding and profiteering might become the order of the day as witnessed in 2008.
Due to the measures introduced, we are mostly likely to witness a multiple pricing mechanism where prices will be pegged according to either the medium of payment (cash or RTGS) or the currency (bond notes, rand or US dollar) one is using to settle obligations. This will lead to massive price distortions as witnessed in the 2008 crisis.
Marukutira is a Zimbabwean economic analyst based in Germany. He can be contacted on Durban.Marukutira@gmail.com